I recently saw a review for Sparklefish on Wired's Geekdad blog and gave it a try. Sparklefish is a perfect Madlibs app for your iPad where it tells you what type of word is next and you press the mic icon to record it. When you've added all the word you can play back you story. The kids LOVE it. An added bonus is that you can save and share you stories.
The app is free and additional stories can be purchased for 99 cents for a 5 pack.
Parenting, Life, and General Geekery though a combination of contstruction, instruction, and destruction.